Using Options to Bottom Fish for Stocks

Bottom fishing stocks is usually a saying used to explain a share purchasing approach which centers on shares in a company whose stock has taken a significant and decisive price dive together with notably increased volume.

The overall rationale is the fact that explosive volume has a tendency to wash the sellers out of the market, leaving it ready for the buyers to come back in and take the share price to higher levels. Hence the expression "bottom fishing stocks" - you're fishing for stocks at what you consider could be the bottom levels of it's price action and well positioned for a turnaround.

Buying These Stocks at a Discount

If you know anything about option trading you'll be aware that you can both buy (go long) or sell (go short) option contracts. You'll also know that in the usa one option contract covers 100 shares while in other places such as Australia, they give you control over 1,000 shares - so you'll need to take this into account in connection with the level of capital you want to invest. Do you plan to purchase multiples of 100 or 1000 shares?

The simplest way to illustrate bottom fishing stocks for a discount using options is to create our own imaginary example. Let's say XYZ company stocks have recently dropped significantly to around $17 on high volume - sometimes called 'capitulation volume'. The stock has since been trading in a price range and you believe it can't fall much further so it's a good buy if it goes as far as the $15 price level. You also have enough capital to purchase 500 shares.

Here's what you can do:

You sell 5 put option contracts for a strike price of $15 for expiry the following month and in addition buy an additional 5 put option contracts for a lower strike price, same expiry date. This is called a put credit spread, otherwise known as a "bull put spread". You need the bought position as a kind of insurance protection in the event the stock plummets further. You can expect to receive a net credit to your brokerage account. Once this is accomplished, three eventualities can follow:

1. The stock stays around the $17 level by option expiry date. In this instance you can keep the credit you have received and may choose to write another put credit spread for the following month. You have effectively been compensated for waiting for the stock to reach your desired level.

2. The stock falls to $15 and you are exercised on your sold options and the stock is put to you. You now own 500 shares of XYZ and can then employ further strategies using options, for example selling covered calls with protected puts.

3. The stock continues its decline to way below $15. In cases like this, the stock will be assigned to you, but your bought puts will increase in value and limit your potential losses. You could use the gain from these bought puts to buy more shares and in the process, average down your entry price as part of a longer term wealth building plan.

Bottom Fishing Stocks Using Inflated Option Prices

One of the reasons bottom fishing stocks is the best time to employ this strategy, is the fact that due to the huge stock selloff, the implied volatility in put option prices will normally be elevated. This means that the near-money options you sell will probably be at inflated prices, thus giving you a better credit for the transaction. You get paid a handsome sum for simply waiting for the stock to fall further - whether or not it does.

Owen has traded options for many years and is writes for "Options Trading Mastery" - a popular site which explores the best option trading systems. Discover some great Option Trading Strategies here and empower yourself for trading success!